2023-08-07 00:55:19 ET
Summary
- The Guggenheim Taxable Municipal Bond & Investment Grade Debt Trust is a high-duration municipal bond fund that suffered heavy losses in 2022 as interest rates rose.
- Long-term interest rates are still rising, which may continue to negatively impact GBAB's net asset value in the short-to-medium term.
- The fund's distribution yield of 9.8% of NAV may not be sustainable, as the portfolio only yields 5.9%, potentially leading to a distribution shortfall.
A reader recently asked about my thoughts on the Guggenheim Taxable Municipal Bond & Investment Grade Debt Trust ( GBAB ). Given the unique features of the GBAB fund, I believe it may be worthwhile to put my thoughts into an article so other investors can see it.
The GBAB fund is a high duration municipal bond fund that aims to pay an attractive distribution yield. For most of its history, the GBAB fund had been able to earn ~6-7% total returns to fund its distribution yield. However, disaster struck the GBAB fund in 2022, as its high duration portfolio suffered heavy losses as interest rates rose.
Looking forward, with NAV reset materially lower, some investors may be tempted to buy the GBAB fund, hoping for a rebound in NAV while earning a 9.3% distribution yield. However, with long-term interest rates still in a rising trend and low by historical standards, GBAB holders may continue to face NAV headwinds. Furthermore, as the fund's portfolio only yields 5.9% compared to its 9.8% of NAV yield, the fund may have to dip into capital to pay its distribution. Over the long-run, this is unsustainable.
I would look to use any upcoming rallies in the GBAB fund to switch out of the fund and into something with less duration and potentially higher yielding.
Fund Overview
The Guggenheim Taxable Municipal Bond & Investment Grade Debt Trust is a closed-end fund ("CEF") that aims to provide high current income from a portfolio of taxable municipal securities and other investment grade, income generating debt securities.
Under normal market conditions, the GBAB fund will invest at least 80% of its assets in taxable municipal securities including Build America Bonds ("BABs", hence the fund's ticker), which quality for federal subsidy payments under the American Recovery and Reinvestment Act of 2009, and other investment grade debt securities. Concentration risk is limited to 25% of assets in any particular state of origin.
The GBAB fund employs leverage to enhance returns and as of July 28, 2023, the fund had $495 million in managed assets and 26% effective leverage (Figure 1). The GBAB fund charges a 2.27% common expense ratio.
Portfolio Holdings
The largest asset class allocation in the GBAB fund is taxable municipal bonds at 55.4%. It also holds 12.7% in investment grade bonds, 7.4% in high yield bonds, 6.8% in bank loans, 6.2% in asset-backed securities ("ABS") and 4.8% in other municipal bonds (Figure 2).
GBAB's portfolio is generally of high quality, with investment grade rated securities totaling over 75% of the portfolio. 33.2% of the portfolio is AA-rated, 22.7% is A-rated, and 19.5% is BBB-rated (Figure 3).
Within GBAB's municipal portfolio, approximately 60% are revenue bonds vs. 24% general obligation ("GO") bonds (Figure 4).
Historically, GO bonds were considered safer than revenue bonds, as they were backed by the full faith and credit of the issuing municipality whereas revenue bonds are issued against a specific revenue source, such as a water utility or a sports stadium. GO bonds have historically suffered lower defaults (Figure 5).
Due to the long-term nature of many municipal bonds, GBAB's portfolio has an overall portfolio duration of 9.4 years (Figure 6).
Returns
Figure 7 shows GBAB's annual and trailing returns. Historically, GBAB's returns were modest, with an average annual return of 6.9% from 2013 to 2021. However, disaster struck in 2022 as the fund returned -25.0%, wiping out years of modest returns and leading GBAB to record 3 and 5Yr average annual returns of -4.8% and 0.3% respectively to July 31, 2023.
GBAB's poor 2022 was the result of the fund's high duration of 9.4 years mentioned above. Since March 2022, the Federal Reserve have increased short-term interest rates by 525 bps. Long-term treasury yields, modeled as the 10Yr treasury yield in Figure 8, increased from 1.5% at the end of 2021 to 3.9% at the end of 2022, or an increase of 2.4%.
Using first order approximation, an increase of 2.4% in 10Yr treasury yields applied to GBAB's 9.4 years duration contributed 22.6% in MTM losses to the fund.
However, as long-term interest rates have stabilized in the past few months, the GBAB fund have returned to delivering modest returns, with 4.8% returns YTD 2023.
Distribution & Yield
The biggest attraction of the GBAB fund is its attractive monthly distribution of $0.1257 / share, maintained since 2016 (Figure 9). The GBAB fund currently has a forward distribution yield of 9.3% on market price and 9.8% on NAV.
Historically, the GBAB has been able to fund its distribution mostly from net investment income ("NII") and capital gains, but for fiscal 2023, the fund had to dip into return of capital ("ROC") to fund 40% of its distribution (Figure 10).
With GBAB's portfolio currently yielding only 5.9% (Figure 11), the GBAB fund may not be able to fully fund its 9.8% of NAV distribution yield.
However, the GBAB fund is not a 'return of principal' fund in the classical sense as the fund had a generally rising NAV until 2022, which indicates the fund was able to earn its distribution in the years up to 2022 (Figure 12).
Instead, my worry is that with long-term interest rates still in a rising trend, GBAB's NAV may continue to face headwinds in the short-to-medium term due to its high portfolio duration (Figure 13).
Given that long-term bond yields are currently not high by historical standards, investors looking for a quick rebound in GBAB's NAV may be disappointed (Figure 14).
Said another way, the GBAB fund appeared to have benefited from a 40-year decline in interest rates that led to modest annual capital gains on bonds supplementing the fund's net investment income. However, with long-term yields normalizing / rising, future distributions may see a shortfall.
Conclusion
The Guggenheim Taxable Municipal Bond & Investment Grade Debt Trust aims to provide high current income from a portfolio of taxable municipal bonds and investment grade bonds. Historically, the GBAB had been able to fund its attractive distribution yield mostly from net investment income while maintaining a stable NAV. However, NAV took a big hit in 2022 due to the portfolio's high duration.
Looking forward, the GBAB fund may have a distribution shortfall given its portfolio only yields 5.9% but the fund is paying a 9.8% of NAV distribution. I would take advantage of any upcoming rallies to switch out of the GBAB fund into investment funds that have less duration and potentially higher returns potential.
For further details see:
GBAB: Look For Rallies To Switch Out